Report Identifies Financial Reporting ‘Fraud Triangle’

Fears of undetected financial reporting fraud feeding into “foreclosure-gate”-type concerns are bringing together insiders worried about their industry’s future.

Financial reporting supply chain representatives agree that increased collaboration and communication among industry participants “can greatly advance efforts to lessen fraud risk.”
It was the main finding of a new report based on input from an industrywide roundtable discussion organized by the Center for Audit Quality in Washington.

Co-vice chair of the CAQ’s governing board Michele Hooper—who led roundtable discussions that brought together corporate executives, internal and external auditors, stakeholders, as well as investors, regulators and academics—reports that consistently participants identified the three basic conditions typically connected to financial reporting fraud, or the “fraud triangle.”

While the concept of the “fraud triangle” introduced decades ago by an expert in the sociology of crime is not new, it continues to help detect and defer financial fraud. Incentive, opportunity and rationalization are recognized as the three “fraud triangle” triggers. And opportunity is easier for business owners to control by limiting in-house chances to commit fraud. Defined as “a material misrepresentation” due to intentional failure to report financial information in accordance with accounting requirements, financial reporting fraud is often committed by employees who have access to assets and information.

Insiders agree that same as in other financial services, in the mortgage industry the best way to mitigate the fraud triangle is by implementing strong, highly ethical corporate culture, promote healthy skepticism that helps strengthen professional objectivity among financial reporting supply chain participants, and ensure extensive communication among the parties involved.

“A collective sharing of ideas and resources could greatly advance efforts to mitigate financial reporting fraud,” said CAQ executive director Cindy Fornelli, which is why report findings are expected to serve as a platform for future initiatives aiming to mitigate financial reporting fraud risk by initially focusing on four areas.

They consist of efforts to advance the understanding of conditions that contribute to fraud, develop techniques that help raise red flags of skepticism if and when necessary, take into consideration both short-term and long-term results, and leverage the role of technology in deterring and detecting financial reporting fraud.

According to Fornelli these four areas represent “the beginning of a coordinated longer-term effort” that will benefit investors and other users of financial reports.
Wider industry collaboration creates new opportunity to be more effective in reducing the risk of fraud, she added, which if undetected can result in a loss of confidence in financial markets, losses in shareholder value and even bankruptcy.

The report, “Deterring and Detecting Financial Reporting Fraud – A Platform for Action,” is part of a CAQ initiative to improve financial reporting fraud prevention.

Since there is no silver bullet solution for eliminating fraud, to further improve the efficiency of its fraud prevention initiatives, CAQ said, it has partnered with three organizations representing participants in the financial reporting supply chain: Financial Executives International, the pre-eminent association for

CFOs and other financial executives; the Institute of Internal Auditors, the internal audit profession’s global voice; and the National Association of Corporate Directors, which is dedicated to advancing exemplary board leadership.

CAQ is also affiliated with the American Institute of Certified Public Accountants. ♦